Thursday, July 26, 2012

In the case of In re Smith, 442 B.R. 550 (Bkrtcy. S.D.Tex. 2010), the bankruptcy court addressed (i)whether Bankruptcy Code § 542(c) applies to a consolidated loan and, (ii) whether it is too late, after execution of a consolidation loan, to determine “undue hardship” under § 523(a)(8). In Smith, debtor borrowed money to send her daughter to Austin Business College for an Associates Degree in Business Technology. That degree has not enabled her daughter, a single mother, to get a job that would support debtor’s daughter and debtor’s grandchild. Debtor's daughter lives in debtor's home and works at Walmart. In 2005, debtor filed a voluntary Chapter 7 bankruptcy petition, but instead of seeking to discharge the student loan debt, debtor attempted to combine the three existing loans into a single loan for ease of payment. Debtor did not seek discharge of the consolidated loan while her bankruptcy case was pending or for several years afterwards. Instead, she tried to pay the loan. Debtor now alleges that she is unable to pay the consolidated student loan, and filed this case seeking a court ruling that the student loan is dischargeable.

The court ruled in favor of the debtor. The court began its analysis by asking whether the consolidated loan was a new loan. The creditor argued that the consolidated loan was a new loan and therefore could not be discharged because it was a post-petition debt. The court found against the creditor on this issue, and held that the consolidated loan was nothing more than a “reaffirmation agreement.”The consideration for the consolidated loan predated the current bankruptcy case. Because no additional advances were made, no new lender advanced funds to pay off the prepetition lender, and no material modifications were made to the loan, the court held that there was no reason to treat the new note as a “loan made.” “The financial effect of a bookkeeping entry on Wells Fargo’s books is not the creation of a new loan, it is a bookkeeping entry that (in this case) has no effect to make the loan dischargeable. Treating this bookkeeping entry as a new loan would elevate form over substance.”

The court then turned its attention to whether a prior discharge under Chapter 7 bars a subsequent determination of dischargeability under § 523(a)(8). Under FED. RULE BANKR.P. 4007(b), a pre-petition student loan is not automatically discharged, but there is no deadline for seeking a determination that § 523(a)(8) applies, and there is no deadline to discharging the debt after the bankruptcy case is closed. “Both the Seventh and Second Circuits have held that debtors are permitted to reopen their cases to seek a discharge of their student loans based on a post-discharge change in circumstances.” In re Walker, 427 B.R. 471, 480 (8th Cir. BAP Minn., 2010).

In this case, debtor testified that she is able to pay her bills as they come due, however, she can only do so by regularly postponing other necessary expenses, such as medical care, home repairs, and car repairs. Also, as a result of debtor's age (56 years old), her income will decline when she reaches retirement. Based on these facts, the court concluded that debtor's financial condition would only worsen over time. Based on facts related to a finding of “undue hardship,” the court concluded that debtor's post-discharge change in circumstances permitted her to reopen her case and seek a discharge of her student loan debt. The court ruled in favor of the debtor and found “undue hardship.”

Apply the law to the facts, the Smith court held to prove that the discharge of student loan debt under 523(a)(8) is possible…albeit, the court construed this case through a very narrow lens, focusing on debtor's extreme financial hardships and low quality of life. However, this case is a twinkle of the “light that’s at the end of the tunnel” for those debtors with extreme circumstances who are deserving of student loan debt discharge.
Sincerely,

In the case of In Re Ayele, 468 B.R. 24 (Bkrtcy.D.Mass. 2012), the bankruptcy court addressed whether debtor was entitled to “undue hardship” discharge of his roughly $30,000 in student loan debt. The court ruled that the debtor was not entitled to undue hardship discharge of his debt, but the court, in exercise of its equitable authority to enter “necessary or appropriate” orders, entered an order discharging any student loan debt which debtor was unable to repay following his participation in the Income Contingent Repayment Plan (ICRP) or income-based repayment (IBR) program.

Rule

The Bankruptcy Code prohibits the discharge of student loan debts “unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents.” 11 U.S.C. § 523(a)(8). There is a split amongst the courts on the proper test to apply in determining whether the debtor has satisfied the undue hardship burden. The Brunner Test is a three-part test which requires the debtor to prove: (1) that the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her dependents if forced to repay the loans, (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and (3) that the debtor has made good faith efforts to repay the loans. Brunner v. New York State Higher Educ. Servs. Corp., 831 F.2d 395 (2nd Cir.1987). Other courts have adopted “the totality of the circumstances test” which requires the court to consider: (1) the debtor’s past, present, and reasonably reliable future financial resources, (2) a calculation of the debtor’s and her dependent’s reasonable necessary living expenses, and (3) any other relevant facts and circumstances surrounding each particular bankruptcy case. Long v. Educ. Credit Mgmt. Corp., 322 F.3d 549, 554 (8th Cir.2003). The Court in this case adopted “the totality of the circumstances test” because it opined the Brunner test to be too expansive.

Facts

A. The William D. Ford Direct Loan Program

Prior to the commencement of this case, the court took notice of the William D. Ford Direct Loan Program (the “Ford Program”), which was enacted by Congress pursuant to 20 U.S.C. § 1087a et seq., and is contained within the Code of Federal Regulations, see 34 C.F.R. §§ 685.100 through 685.402. The Ford Program provides for student loan consolidation under the guaranteed student loan program, and an income contingent repayment plan (“ICR Plan”). In addition to ICR Plans, student loan borrowers may be eligible for an Income-Based Repayment program (the “IBR program”) as part of the Ford Program. An understanding of the Ford Program helps to facilitate a complete legal analysis of the Court’s opinion in this case.

Under the ICR Plan, the monthly payment amount is calculated as the lesser of: (a) the amount that would be paid if the borrower repaid the loan in 12 years, multiplied by an annual income percentage factor that varies based upon the borrower’s annual income; or (b) 20% of the borrower’s discretionary income, which is defined as the borrowers adjusted gross income (“AGI”) minus the poverty level for the borrower’s family size.

The IBR Program is part of the College Cost Reduction and Access Act of 2007. Under the IBR Program, the amount an eligible borrower would repay each month under the IBR is based on the Borrower’s AGI and family size. The annual IBR repayment amount is 15% of the difference between the borrower’s AGI and 150% of the Federal HHS Poverty Guidelines, adjusted for family size. That amount is then divided by 12 to get the monthly IBR repayment amount. If that amount is higher than the 10-year standard repayment amount on the borrower’s loans, then the borrower’s required payment is the standard amount. The repayment amount under a 10-year standard plan is calculated based upon the total.

B. Stipulated Facts and the Debtor’s Testimony

Debtor, a native Ethiopian, is 53 years old, divorced, and has no minor children. He filed a Chapter 7 petition in 2010 and listed unsecured creditors holding claims totaling $34,867.91, including Educational Credit Management Corporation (“ECMC”) with a claim totaling $29,925.42.

Debtor has acquired several degrees from various American educational institutions. He received: (1) Associate Degree in Business administration from South Central Community College in New Haven, Connecticut, (2) a Bachelor of Science Degree from Southern Connecticut State University in New Haven, Connecticut, (3) a Masters of Science Degree in Administrative studies from Boston University.

Throughout his adult life, debtor has only held hourly wage jobs, earning no more than nine to ten dollars per hour. Although debtor does not keep records of his expenses, debtor set forth monthly expenses totaling $1,062. In addition to typical monthly expenses, debtor also sends money to his sister to support her and her family in Africa. At the time of this case, debtor has collected unemployment payments of $700 per month for the past nine months. In spite of his unemployment, debtor testified that he has sent out over 600 resumes and job applications in his attempt to find employment suited to his educational level. He testified that his inability to secure employment is due to his accent and racism.

Debtor testified that he will no longer accept employment as a per hour wage earner. He explained that if he accepted such employment “life will never change.” He also testified that he did not apply for a federal loan consolidation through the Ford Program, because he “wanted the Judge to decide the case based on his economic status.”

Debtor contends that repayment of his student loan debts would present an undue hardship because he cannot afford to repay the debt, and he is unlikely able to repay it in the foreseeable future. ECMC argued that debtor failed to sustain his burden, and that he failed to show that his future prospects are bleak enough to warrant the discharge of his student loan debt.

Holding

Ultimately, the court found that debtor introduced evidence to suggest hardship; however, debtor did not submit evidence to permit a finding of undue hardship. The court ruled in favor of ECMC holding that debtor was not entitled to undue hardship discharge of his student loan debt. The court found dispositive that due to his advanced degrees the debtor would eventually obtain employment, and that despite his eligibility he did not participate in an ICR Plan or IBR program. However, the court exercised its equitable authority discharging any student loan debt which debtor was unable to repay following his participation in the ICRP Plan or IBR program so as to avoid a negative tax consequences (arising from the negative amortization of the debt over time when payments are not made and the tax implications arising after the debt is cancelled).

Like Hedlund v. Educational Resources Institute, Inc., 468 B.R. 901 (D.Or. 2012), this case demonstrates the discretionary authority of the courts in applying the Brunner "undue hardship" test. In this case, the court found that the second prong of Brunner test had not been met; predominantly the fact that due to debtor's advanced degrees it was likely that he would obtain future employment.

Thursday, July 19, 2012

In the Case of Hedlund v. Educational Resources Institute, Inc., 468 B.R. 901 (D.Or. 2012) the court addressed whether debtor was entitled to a partial "undue hardship" discharge of his approximately $85,000 in student loan debt. The bankruptcy court granted the student loan discharge, but the Ninth Circuit reversed the bankruptcy court's decision.

Debtor obtained a bachelors of science degree in business administration from the University of Oregon and a law degree from Willamette University. Debtor financed law school by obtaining federal Stafford student loans totaling $85,245.87. Debtor's father and brother are attorneys in Klamath Falls, Oregon, where debtor resides. After graduating from law school, debtor obtained a position with the District Attorney's office in Klamath Falls. Debtor planned on staying at the District Attorney's office for a couple of years, after which time he would then work at his father's law firm. Debtor, however, was unable to pass the bar exam despite sitting for it twice (once in 1997, and again in 1998), and failing to make it to the exam on exam day the third time (in 1999). As of the time the case was filed, debtor had no plans to retake the exam.

Because debtor was unable to practice law, he filed for and received several extensions of his loan obligation. In 1999, debtor's loans went into repayment status, at which time debtor submitted an application for loan consolidation. Because debtor fell behind on his payments under the loan consolidation, debtor was unable to re-apply for consolidation. Debtor chose not to apply for the William D. Ford Income Contingent Repayment Program because he believed that he did not qualify for it.

In 1999, debtor obtained a job as a juvenile counselor at the Klamath County Juvenile Department. Although debtor worked full-time, he did not make the requisite monthly loan payments. In fact, debtor made only one payment on his debt prior to filing for bankruptcy; in September 1999, debtor advanced $954.72 to the creditor using the proceeds of a $5,000 inheritance. Subsequently, debtor made a one-time payment offer to creditor of $5,000 in exchange for more favorable loan terms and waiver of certain assessed fees; creditor declined his offer.

In 2000, debtor got married, and in 2001, debtor and his wife had their first child. Debtor's wife works at a flower shop one day per week for six hours, earning $8.50 per hour. Debtor's wife has the potential to work more, but instead chooses to stay at home with their child.

After two years of nonpayment, the creditor administratively began to garnished debtor's wages. The following year, a second student loan creditor also began to garnish wages from debtor's bank account. Unable to simultaneously manage both garnishments, debtor filed a petition for relief under Chapter 7 of the bankruptcy Code. At that time, debtor was thirty-three years old, married, with one dependent child; he was healthy, had no physical disabilities, and had no drug or alcohol addictions. His annual income was $40,320.

The court began its analysis by applying the three-part Brunner test. Under Brunner, a debtor must prove that: 1) he cannot maintain, based on current income and expenses, a "minimal" standard of living for himself and his dependents if required to repay the loans; 2) additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and 3) the debtor has made good faith efforts to repay the loans. See United Student Aid Funds, Inc. v. Pena (In re Pena), 155 F.3d 1108, 1111-12 (9th Cir. 1998) (adopting the Brunner test).

On appeal from the bankruptcy court, the 9th Circuit independently reviews findings of fact for clear error, while conclusions of law are reviewed de novo. Schwarzkopf v. Briones (In re Schwarzkopf), 626 F.3d 1032, 1035 (9th Cir.2010). Mixed questions of law and fact, such as the proper application of legal standard in determining whether a student loan is dischargeable, are also reviewed de novo. Educ. Credit Mgmt. Corp. v. DeGroot, 339 B.R. 201, 214-15 (Bankr.D.Or.2006).

A. Minimal Standard of Living

The first prong of the Brunner Test requires the debtor to establish that he could not maintain, based on his current income and expenses, a minimal standard of living if he were required to repay the creditor. More than "simply tight finances" and "temporary financial adversity" must be demonstrated; however, a showing of "utter hopelessness" is not required. Rifino, 245 F.3d at 1088. Determining what constitutes a minimal standard of living for each individual debtor requires a case-by-case assessment. The applicable test is whether it would be unconscionable to require the debtor to take steps to earn more income or reduce his expenses in order to make payments under a given repayment schedule. Carnduff v. U.S. Dep't of Educ. (In re Carnduff), 367 B.R. 120. 127 (9th Cir. BAP 2007).

Analyzing the first element, the bankruptcy court determined that debtor had maximized his income, and that it would be unconscionable to require him to work more than forty hours per week. However, the bankruptcy court determined that it would not be unconscionable to require the debtor's wife to work more days per week, especially given the availability of free child care from the grandparents. The court also found that debtor could reduce his monthly expenses by slightly abating his monthly expenses for recreation, clothing, and child care budgets. After factoring in these adjustments, the court concluded that the debtor's monthly surplus was insufficient to make the requisite monthly loan payments. Consequently, the bankruptcy court found that debtor satisfied the first prong of the Brunner test. The Ninth Circuit could not find that the bankruptcy court committed clear error when applying the first prong of the Brunner test.

B. Additional Circumstances

The second prong of the Brunner test requires the debtor to prove that "additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans." The court must "presume that the debtor's income will increase to a point where he can make payments and maintain a minimal standard of living; however, the debtor may rebut that presumption" by introducing evidence "indicating that his income cannot reasonably be expected to increase and that his inability to make payments will likely persist." Educ. Credit Mgmt. Corp. v. Nys (In re Nys), 446 F.3d 938, 95 (9th Cir.2006). The bankruptcy court found that debtor's lack of admission to the bar, his inability to substantially increase his income over the loan repayment period (because he maximized his income in his position, and the closest promotion was eight years away), the absence of current assets, and likelihood that expenses will increase over time because he wants to have more children, were additional circumstances proving that debtor's current financial position is likely to persist for a significant portion of the repayment period. The Ninth Circuit found that the bankruptcy court did not err in regard to the second prong of the Brunner test.

C. Good Faith

The third prong of the Brunner test requires the debtor to affirmatively demonstrate a good faith effort to repay student loans. To do this, the court analyzed a number of factors, including the debtor's efforts to obtain employment, maximize income, minimize expenses, and to negotiate an alternative repayment plan, as well as his history of voluntary payments.

The court begins its analysis of this prong of the Brunner test by acknowledging the bleak circumstances faced by the majority of today's law school graduates. However, the Court found that the debtor's case is distinguishable. The debtor graduated in 1997, a period of great prosperity and rapid economic growth for the United States. Even though debtor was unable to pass the bar exam, he was able to obtain a relatively high-paying job. Moreover, debtor and his wife chose to be a single-income family, which is a lifestyle that few today can afford, especially when free child care is available. Therefore, the court determined that the debtor's financial circumstances are, in part, a by-product of his life choices rather than market forces.

However, the court noted that a more dispositive factor was that the debtor did not meet his burden of proof in showing an affirmative demonstration of good faith. Debtor not only neglected to maximize his income, minimize his living expenses, and make voluntary payments, but he also failed to take any steps toward renegotiating an alternative repayment plan. The court determined that these factors were not beyond his reasonable control. Consequently, the Ninth Circuit found that the bankruptcy court erred as a matter of law in finding that debtor met the third Brunner Prong.

Because the debtor failed to prove the third prong of the Brunner test, the bankruptcy court's order discharging debtor's student loan debt was reversed, and debtor was required to pay off the full debt in the amount of $ 85,245.87.